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When does regulatory misconduct justify “life”?

In our May publication, we reported on the issue of how much leniency persons under investigation who cooperate with the SFC are entitled to expect. Since then, the SFC has completed some 227 enforcement cases resulting in the issuance of 42 disciplinary sanctions (with seven life bans imposed in 2010 alone), commenced 41 criminal prosecutions and brought 10 civil proceedings: see SFC Enforcement Reporter Issue Nos. 66 & 67. Furthermore, the SFC has also reported that its market surveillance team has been initiating more than 350 inquiries into suspicious trading activities every month. This constitutes a significant increase in work levels. Faced with this apparent staggering increase in the severity of sanctions imposed, in this publication we address below the changing philosophy of the regulator on life bans.

Introduction

Since 1997, the SFC has imposed 32 life bans, of which the vast majority has been imposed within the last five years. Broadly speaking, life bans have been imposed:

whenever misconduct involves the misappropriation/theft (or attempted theft) of client assets of whatever value (e.g., attempted theft of $12,000 in 2003 resulted in a life ban);

where the dishonest behaviour was designed to deceive or otherwise harm the interests of investors, especially when deliberately concealed to prevent detection; and

where the misconduct takes place over a long period of time and involves the abuse by responsible officers of their seniority in procuring the assistance of subordinates to conduct unlawful activities.

Furthermore, it also seems clear that even where the person under investigation has received no direct benefit, the SFC has sought to impose penalties commensurate with the indirect benefit derived, such as bonuses paid.

The SFC’s Guidelines

As a starting point, it is important to note that life bans reflect the statutory maximum (indirect) non-pecuniary sanctions available to the SFC: section 194 SFO.

According to the SFC’s guidance note (“Disciplinary Proceedings at a Glance”), when making disciplinary decisions, the SFC will have regard to its previous decisions unless changed circumstances warrant an adjustment to its penalties and will aim to impose sanctions which are considered “proportionate” to the gravity of the alleged improper conduct. It also provides a non-exhaustive indication of the factors which the regulator will take into account in determining the level of sanction, which include:

the impact of the conduct in question upon market integrity;

the degree of losses caused to clients;

the duration and frequency of the conduct, whether such conduct is widespread within the industry;

whether there has been a breach of fiduciary duty;

the degree of cooperation with the SFC’s investigation; and

the past disciplinary record, experience and position/role of the person accused of misconduct.

The Right to Review “Life Bans”

Whilst in theory a person aggrieved by an SFC decision to impose a ban may apply to the Securi-ties & Futures Appeal Tribunal (“SFAT”) to review such a penalty, the SFAT has shown itself to be extremely reluctant to interfere with SFC sanctions, or substitute its own view for that of the regulator.

To date, three appeals1 to the SFAT to lift life bans have been made and none has succeeded. The attitude adopted by the SFAT is that unless the SFC has failed to take into account relevant factors (or took into account irrelevant factors), or the appli-cant has not been afforded sufficient opportunity to present its case or respond to the SFC’s case, it would be inappropriate to interfere with the SFC’s decisions and primacy must be afforded to the views of the regulator “on the ground”.

The SFAT New Philosophy to “Life”

In Ng Chiu Mui & others v SFC (CACV 141/2009), the Court of Appeal recently considered the role of the SFAT in evaluating the SFC’s disciplinary findings in the course of which it commented on the SFAT’s willingness to impose life bans.

In Ng Chiu Mui, the SFC took disciplinary action arising out of offers made by an off-shore entity to Hong Kong investors to induce the use of off-shore unlicensed foreign exchange services. The regulatory regime in Hong Kong prohibits active marketing (whether in or outside Hong Kong) to Hong Kong investors of services that would otherwise be regarded as regulated activities. The rationale is that Hong Kong investors would otherwise be deprived of statutory protection for resulting losses.

The SFC’s Notice of Proposed Disciplinary Action (NPDA) invited the appellants to make submissions to answer the case against them but neither did so (notwithstanding an extension of time to make such submissions). Thereafter, the SFC proceeded to issue its Notice of Final Decision, together with reasons, against each appellant and, among other things, imposed a life ban on one appellant.

The appellants later applied to the SFAT to review the SFC’s findings and the life ban. This appeal was primarily based on a jurisdictional challenge—the appellants asserted that the unlicensed activities were conducted outside Hong Kong and therefore not subject to the Hong Kong regulatory regime. During the course of a directions hearing, the appellants indicated that they would give evidence before the SFAT but then ultimately declined to do so to avoid cross-examination.

Although the SFAT (Stone J) upheld the SFC’s findings, among other things, the SFAT reduced the SFC’s life ban to a 10 year prohibition. The SFAT stated it “was philosophically disinclined to favour life bans” (see paragraph 96).

The Court of Appeal’s Attitude to “Life”

The appellants, however, pursued a further appeal to the Court of Appeal (CA), arguing, among other issues:

A procedural point that the SFAT merely accepted the SFC’s findings without conduct-ing an independent evaluation. This ground of appeal was dismissed. The CA ruled the SFAT’s conclusions were considered in “light of the available material”. The appellants had elected to decline to make any submissions in response to the NPDA and then declined to give any evidence before the SFAT. Accord-ingly the SFAT was entitled to reach the con-clusions it did.

The imposition of a 10-year suspension was manifestly excessive and implicitly reflected the SFAT’s displeasure that the appellants had not given evidence. The CA disagreed. It held even if the SFAT felt frustrated by the appellants’ failure to give evidence it did not impose a “heavier” sentence and the appel-lants should therefore consider themselves fortunate.

Critically, however, the CA endorsed the views of the SFAT and said that few cases of misconduct could be said to justify “life” in the true sense and, in the case of the second appellant, that there was arguably a lack of internal consistency in the penalties meted out and varied ‘downwards’ the sentence.

Conclusion

The Courts and the SFAT have clearly emphasized the need for proposed disciplinary sanctions to be carefully calibrated to ensure that maximum penalties are only pursued if “proportionate” to the gravity of the alleged improper conduct. Past precedent of SFC sanctions in itself is unlikely to usurp the SFAT’s view calling for a more proportion-ate and tailored regulatory approach. However, at the same time, persons under investigation ought to carefully assess the potential downside of adopting a forensic ‘strategy’ of failing to make any represen-tations to the SFC upon receipt of the NPDAs or declining to give evidence. The SFC’s disciplinary process will be upheld as fair provided the SFC acts reasonably in giving an affected person an opportunity to be heard on the substance of any charges and proposed penalties.

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